Social Security taxation is complex. You may need to pay taxes on your benefits, or you may not have to pay taxes. Ultimately, your combined income will determine if you pay taxes and will include the sum of:
- Adjusted gross income
- Non-taxable interest
- Half of your Social Security benefits
Often, clients of ours are taken aback because they paid into Social Security their entire lives, and then they find out that they may be taxed on their benefits. For many of our clients, the benefits that they receive are not enough to live the lifestyle they want in retirement, so they’ll need other sources of income, such as distributions from their IRA.
We brought Taylor Wolverton, a member of our team, to our podcast to discuss how your Social Security is taxed because there are a lot of moving parts to consider. Taylor is our lead tax strategist and an Enrolled Agent, so she’s hyper-focused on individual taxation.
P.S. We are going to go through a lot of numbers, so take your time and reread this post a few times. However, if you do have questions about your specific situation, feel free to schedule a free 15-minute call with us.
Breaking Down the Figures
We have three main factors in determining how much of your benefits are taxable, but what do these really encompass?
What is Adjusted Gross Income?
Adjusted gross income (AGI) includes:
- Interest from savings accounts
- IRA or other distributions
Your AGI includes any type of income that you’ll be taxed on in a given year.
What is Non-taxable Interest?
Your non-taxable interest comes from things like municipal bonds. Now, you must combine all this income plus half of your Social Security benefits. It’s a lot to consider.
Example of Taxation on Social Security
Someone has other sources of income of $75,000. Bob and Jane each receive $3,000 per month from Social Security ($6,000 total). Based on this example, there is:
- $75,000 AGI
- $0 tax-exempt interest
- 50% of Social Security benefits, or $36,000 annually
Other sources of income are now $75,000 + $36,000 or $111,000. Now, it gets a little more complicated because of your tax filing status and the various thresholds that this may include.
Married Filing Jointly
If your income is between $32,000 and $40,000, up to 50% of your benefits may be taxable. However, if the couple’s income is more than $44,000, up to 85% of benefits will be taxable.
In the example above, the couple has $72,000 in Social Security benefits, so $61,200 will be reported on the couple’s tax return and will be taxable.
Going over these figures again, based on these calculations, the couple would have:
- $75,000 AGI
- $61,200 (85% of $72,000) from Social Security
Total taxable income is $136,200.
Note: For people who have income less than $32,000, you might not pay any taxes at all on your Social Security. However, taxation is on a sliding scale. At the most, 85% of your benefits are taxable.
Thresholds for Single, Head of Household, Qualifying Widow(er), or Married Filing Separately (and you did not live with your spouse during the year)
A single person will have a different threshold for Social Security. You’ll be taxed up to 50% if you have income of $25,000 – $34,000. You may be taxed up to 85% if you have income of more than $34,000.
You’ll want to keep in mind that taxes are a bit more complicated than the examples above. We used approximations for these figures, but you’ll also need to consider credits, deductions, and special financial situations, which can lower your tax bill, too.
Variations Based on States
All the taxation above this point is based on the federal level. Every state has different rules that you must consider when retirement planning because some may follow federal rules, while others may not tax Social Security.
In North Carolina, where our office is located, there is no tax on Social Security, and this can be advantageous when trying to secure your retirement.
How Social Security Taxation Impacts Retirement Planning
When looking at Social Security taxation, it’s important to know:
- Sources of income
Often, one of the largest expenses people have is the taxes that they need to pay in retirement. You’re not saving money for retirement any longer – you’re living off what you saved.
You need to understand how Social Security benefits will impact your taxes this coming year.
It’s possible to withhold taxes in some areas to lower the pending tax burden, but this is something that you need to consider well ahead of time. You never want to have a surprise when filing a tax return because you didn’t realize that Social Security is taxed.
Example of the Impact Social Security Had On One Client
One client of ours has the goal of leaving a tax-free legacy behind when she retires. She turned on Social Security, but she didn’t realize that she would be taxed on her benefits.
What did she do?
- Turned off Social Security
- Paid it back
- Leveraged Roth conversions for a few years
- Turned benefits back on
She wants to leave a tax-free legacy behind, so it was crucial to make the most out of tax-free Roth conversions.
While she did have to pay back the benefits she received, she does benefit from higher Social Security benefits when she does decide to take them in the future.
Working with an advisor allows you to take the long-term approach to your Social Security and maybe avoid 85% of your benefits being taxable. A long-term perspective, based on your goals, needs to be considered.
Our goal is to limit the amount of taxation over a lifetime rather than a short period of time.
You may find that paying more taxes this year allows you to lower your burden over your lifetime. If you pay a bit more in taxes today but save 10% every year, it’s often in your favor to take the tax hit immediately.
Where to Learn How Much of Your Benefits Were Taxable
Pull out your most recent tax return and find your 1040 form. Often, this is the first page of your return. You’ll want to go to line 6a. This will show you how much of your benefits were for that year. If you look to the right to 6b, you’ll see how much of your benefits were taxable.
IRS officials do like to update income tax brackets and change percentages around for inflation. You’ll need to consult with us or a tax professional to learn the current year’s guidelines for income ranges and maximum taxation percentages.
The IRS does have an online calculator (here) where you can plug in data and learn how much of your benefits are taxable.
Do you want to talk to us about your tax situation?Schedule a free 15-minute call today.